2 Main issues :  How are inflation and unemployment related in the short run? In the long run?  What factors alter this relationship?  What is the short-run cost of reducing inflation?

3  In the long run  The inflation rate depends mainly on growth in the money supply  Unemployment (the “natural rate”) depends on the minimum wage, the market power of unions, efficiency wages, and the process of job search.

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4  In the short run , society faces a trade-off between inflation and unemployment.  If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation.  If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment.

5 The Phillips Curve  Phillips curve : shows the short-run combinations of unemployment and inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve.  1958: A.W. Phillips showed that nominal wage growth was negatively correlated with unemployment in the U.K.  1960: Paul Samuelson & Robert Solow found a negative correlation between U.S. inflation & unemployment - named it “the Phillips Curve.”

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